SEC makes first whistleblower payment under Dodd-Frank program

The Securities and Exchange Commission (SEC) announced Aug. 21 that it made its first payout to a whistleblower under a program authorized by the Dodd-Frank Wall Street Reform and Consumer Protection Act. In a press release, Sean McKessy, chief of the SEC’s Office of the Whistleblower, declared the commission “open for business.”

The SEC says the whistleblower received around $50,000 for providing documents and other “significant information” that led to an accelerated investigation and enforcement action into a multimillion-dollar securities fraud—just the kind of information and cooperation the SEC had hoped the program would yield.

The SEC has taken pains to preserve the anonymity of the award recipient, and information is scant on the details of the case, but the announcement marks the first shot fired in a program that the SEC hopes will help it identify and weed out violations that traditionally occur behind closed doors.

“I predict that many of the most significant cases the SEC is going to be bringing in the coming years will be the result of SEC whistleblowers, and this first award is the beginning of this revolution in securities enforcement,” says Jordan Thomas, a former assistant director at the SEC. Thomas helped develop the legislation and implement the program rules. He now represents whistleblowers in securities fraud matters as a partner at Labaton Sucharow.

Speed and Secrecy

The SEC’s whistleblower program makes tipsters who offer high-quality original information that leads to an SEC enforcement and more than $1 million in sanctions eligible for a reward of 10 percent to 30 percent of the amount collected in an SEC enforcement action.

The program launched in August 2011, the preliminary order for its first whistleblower award was filed in May 2012 and the final order for payment was published Aug. 21, making this a remarkably quick award.

“In that time, not only has the SEC received the tip, pursued a tip and investigated it, but they’ve also negotiated a settled case and released it to the public,” says Jonathan Green, counsel in the white-collar litigation and internal investigations group at Kaye Scholer. “This is fast for the SEC. They clearly wanted to make the point that they’re taking tips seriously.”

The SEC’s 2011 annual report revealed that only 61 percent of the commission’s enforcement actions are filed within two years of the start of an investigation. And Thomas says those cases are typically simpler than the complex types of cases that SEC whistleblowers bring to the commission. The quick resolution of this case, he says, is likely the result of a well-placed and valuable whistleblower.

The identity of that whistleblower remains unknown, and the information the SEC has released about the associated enforcement action is vague. It’s unclear whether the parties charged or investigated in this matter are aware of the whistleblower’s identity, but the SEC has withheld it from the public, signaling to potential future whistleblowers—who often face backlash and blacklisting—that protecting their anonymity is a high priority. Aside from that, the law now demands it, specifying that the SEC can’t disclose any information that could directly or indirectly reveal a whistleblower’s identity.

“By maintaining confidentiality, the SEC is saying that it will take steps to protect whistleblowers and won’t just expose them to harsh scrutiny,” says Jonathan Sack, a partner at Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, and former chief of the Criminal Division of the U.S. Attorney’s Office for the Eastern District of New York.

The SEC simultaneously announced that it rejected a claim from another whistleblower seeking an award in the same matter because the information that person provided “did not lead to or significantly contribute to” the action.

“The SEC is trying to communicate to the legal public and the whistleblowing public how the system will work—that the system is discriminating, and that it will involve drawing distinctions between whistleblowers,” Sack says. “The SEC wants to show not just that it’s eagerly handling whistleblower information and bringing enforcement actions based on that information, but that it’s doing it in a very careful and appropriate way and is drawing appropriate lines.”

Modest Start

At around $50,000, the first reward is not enormous, easily overshadowed by the record $104 million IRS payment to whistleblower Bradley Birkenfeld announced just a few weeks later. However, according to the SEC, $50,000 represents 30 percent of the amount collected so far in the whistleblower-aided enforcement action—the maximum amount payable under the SEC program. It’s a strong signal to potential whistleblowers that the SEC is willing to pay the top amount for quality tips.

Because the enforcement action led to more than $1 million in sanctions, the whistleblower will collect more money as the defendant(s) continue to pay the court-ordered amount and if the court issues final judgments against additional defendants in the matter.

State of Things

The SEC is financially ready for future payments to this first whistleblower and subsequent ones. Currently there is more than $452 million in the SEC’s Investor Protection Fund, which funds the whistleblower award program as well as the operations of the SEC Office of the Inspector General’s suggestion program. The funds come from SEC disgorgements and penalties that have been held for investors but that can’t be paid out for some reason: for example, because the SEC can’t identify who was harmed.

The SEC said it received about 3,000 tips from whistleblowers in the program’s first year and currently gets about eight whistleblower tips a day. As part of the rulemaking process’s economic analysis of the impact of whistleblower submissions on the commission, Thomas says, the SEC estimated a 10 percent increase in tips. Prior to the whistleblower program’s implementation, the SEC annually received around 30,000 tips, complaints and referrals—the government’s estimate was rather on the money.

“To see a 10 percent increase in tips is consistent with the estimate and manageable for the commission,” Thomas says. “There were concerns … that the commission would be inundated and these tips would fall through the cracks, and that has not been the case.”

Corporate Considerations

The primary, initial and enduring concern for corporations regarding the Securities and Exchange Commission’s (SEC) whistleblower program was that it would incentivize employees to bypass internal corporate reporting lines and go straight to the SEC with any suspicions or evidence of misconduct. Jordan Thomas, an architect of the program who now represents whistleblowers as a partner at Labaton Sucharow, says the majority of his whistleblower clients report internally first.

A 2011 survey of employee whistleblowers by the Ethics Resource Center reported that only 2 percent of employees report solely externally without first reporting wrongdoing to their employer. Of the 18 percent of employees who do report externally, 84 percent first tried to report internally.

Burgeoning whistleblower programs across government agencies have made it more important than ever for corporations to maintain a strong internal whistleblower reporting system that allows anonymous tips and takes them seriously.

“The worst thing for a corporation is to have someone report internally, sit on it and then have the person go to the SEC later,” says Jonathan Green, counsel at Kaye Scholer. “The SEC will take a careful look at what the company did when it first learned this information.”

Thomas says the SEC whistleblower program has led to many responsible organizations re-evaluating their internal procedures and general ethical climate.

“It has been a positive development for investors and hopefully will result in fewer enforcement actions,” he says.